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Aon Retirement and Investment Blog

We live in eventful times – the case for event-driven investing

There has been a significant pick up in the level of merger and acquisition (“M&A”) activity over the past 18 months; 2015 was a record breaking year with $4.3trn worth of deals announced led by US companies. Although many companies already have cash to spend on acquisitions, those that do need to borrow are benefiting from the availability of debt finance, a key driver of M&A activity, which is being supported by universally low interest rates and investors search for yield. In addition, anemic economic growth is driving consolidation within industries and forcing companies to seek growth through acquisition. Near-term the uncertainty surrounding the Brexit referendum has had a dampening effect on M&A activity since the UK is a typical target for international companies; however, in spite of this, we expect the market backdrop to continue to support an elevated level of M&A activity in 2017.



Event-driven investors are seeking to uncover mispriced securities of companies because of corporate events such as spin-offs, mergers and acquisitions, companies undergoing reorganizations, takeovers or even bankruptcies and liquidations. In merger arbitrage, managers are seeking to profit from the spread between the price at which a company (target) trades after a deal is announced and the price at which the acquiring company has agreed it will pay for that target.The spread exists due to the uncertainty that the transaction will close and there are a number of factors that can affect this; the time it will take to complete the transaction, tax implications of the deal, the need for a shareholder vote on the acquirer and so on. In the second quarter average annualised spreads on deals widened to 17%; well above historical averages. This was in part because of the high profile acquisition of Pfizer by US pharmaceutical Allergan being essentially blocked by the US government, which took a negative stance on the deal that was perceived to be for tax advantages.

This caused spreads to widen as the market expressed concerns over the risk of other deals breaking. However experienced managers are able to mitigate some of this uncertainty through carrying out their own analysis, often hiring lawyers to better understand possible regulatory issues surrounding a deal, to assess the likelihood of the deal closing. As such event-driven managers can generate attractive levels of return from merger arbitrage and the market environment looks set to continue to support a healthy pipeline of M&A activity going forward.
 
Event-driven managers will also invest in companies in distress
 
Those tailwinds supporting the environment for M&A activity, namely the accessibility of funding, have over the past few years enabled companies in financial or operating difficulty to stave off default, as the demand for yield saw capital continue to flow to lower credit quality companies. However the tide could be changing, and this year we have seen an increase in corporate defaults. Distressed debt strategies, a sub-set of the event-driven strategy, will invest in companies that are in financial or operating difficulty or even bankruptcy and seek to profit by leading a restructuring. 



This year the increase in defaults has largely been confined to energy and metals and mining driven by low global commodity prices; outside of the commodity sector, the corporate default rate has remained relatively low. However, we continue to see credit issues in individual companies and specific industries. Retail, for example, is a sector that has been disrupted as consumer spending has migrated to the internet, and the debt burdens of pre-crisis buyouts present a challenge for re-financing options. The debt of the retailers Nine West, J Crew  and Claire’s all fell to distressed levels in 2015 as the companies faced financial and operational difficulties and traditional holders of the debt were forced sellers. This can present compelling opportunities, with the prospect of high double digit returns, for event-driven managers with both the expertise and resources to source investments and perform the detailed analysis required to work out a corporate restructuring or even a liquidation process. Although corporate defaults are still well below the peak they reached during the financial crisis, we will continue to see opportunities for distressed debt strategies due to slowing global growth, weaker earnings, higher levels of leverage and the pace of innovation disrupting some industries.
  
A compelling opportunity set for event-driven strategies
 
Event-driven managers that are multi-disciplined with an established global presence and the skill to delve into complex capital structures and legal terms are well-positioned to take advantage of the current and future opportunity set that is being created by these market forces in the corporate sector. The strategy can offer a relatively idiosyncratic source of return compared to more traditional equity and fixed income assets.
 
Alison Trusty is a hedge fund specialist in Aon Hewitt’s Global Investment Manager research team in London

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